Is the storm beginning to part for conservative investors? John Bailey Milford Client Manager, June 10, 2022
The first half of the year has been very tumultuous for investors across the board, there is no other way to say it. Due partly to the conflict in Europe, inflation running hot globally and interest rates beginning to rise, volatility has come back to the financial markets in a big way. Investors around the world are looking to central bank messaging for any indication as to the path ahead for interest rates. Too hard and fast could hurt the economy, however, too slow and prices could rage out of control. Central Banks are in a difficult situation, presently performing a meticulous balancing act.
Why has this happened? Why are Bonds being sold off in such volatile times? Inflation has hit 30-year highs due to the huge amounts of monetary and fiscal stimulus used to support economies during the COVID-19 era. This, coupled with supply-chain disruptions and rising oil prices has sparked a need for urgent action from central banks to get rising prices under control. New Zealand was quick off the mark to begin raising interest rates to combat inflation and has been closely followed in recent times by the United States, the United Kingdom and Australia. Bond prices have an inverse relationship to interest rates so when interest rates rise, current bond prices fall. Even the expectation of interest rate rises can have a heavy effect on the current price of a bond. The large sell off in bonds at the start of 2022 was largely due to investors’ future expectations that central banks need to raise interest rates to fight inflation. This chart taken from the RBNZ website shows the significant increase in inflation in recent times.
An unfortunate consequence of the expectation of rising interest rates is that conservative investors, investing primarily in bonds, have experienced high levels of volatility. So much so that their experience has been similar to that of equity investors so far in 2022. There’s a good chance that this will have taken many by surprise. Bonds, which are a great source of portfolio diversification and normally act as a strong hedge against share-price volatility, have had the worst start to the year since record keeping began! The Bloomberg chart below shows just how hard bond prices have been hit since January. Each line on the chart shows the calendar year performance of bond returns over the past 30 years. 2022 (bold line) is clearly the standout as the worst performance.
While the chart above looks concerning, it also gives us comfort in knowing that we have seen spikes in inflation before. Central banks will continue to raise interest rates to slow down economies and bring prices under control. History shows that sooner or later, they will be successful in their mission. Milford has been under-weight fixed income securities such as bonds in our multi-asset funds and portfolios since the beginning of this year. The strategy of holding higher levels of cash and not investing more into bonds has helped mitigate some of the volatility that our conservative investors will have felt.
